Who’s to pay for Y2K?

AT ABOUT this time a year ago, companies all over the world were in the final stages of a costly eradication programme to kill off the millennium bug. They had 100-strong teams working away feverishly, replacing computers and updating systems. Then, on the first day of 2000, nothing much happened, either in companies that had prepared diligently for potential Y2K computer problems, or in those that had not. The exercise had cost millions of companies in America hundreds of billions of dollars.

Not surprisingly, many then began to look around for someone with whom to share this huge (and maybe unnecessary) cost. In the process, some took a close look at their property-insurance policies and discovered an obscure “sue and labour” provision. The clause, which originated in marine policies in the 17th century, allows policyholders to recover some of the cost incurred in efforts to prevent a loss. The principle is a bit like a healthy person claiming the price of a medical check-up because it saves the insurer paying for illnesses that are subsequently avoided.

Xerox, Unisys and Nike were among the first companies to take their insurers to court on these grounds. Xerox is suing its insurer, American Guarantee & Liability Insurance, for $183m, one of the biggest claims over the cost of Y2K. It could do with the money. There are persistent concerns about the financial health of the deeply indebted copier company.

The companies taking their insurers to court argue that the insurance industry lobbied actively for extensive preparations to avoid being bitten by the computer bug. Even on their websites, insurers posted urgent calls for policyholder action. Companies obliged, at vast expense. So they consider it only fair that their insurers bear part of the cost. Moreover, they point out that some insurers amended their property policies to exclude coverage of Y2K problems. It is hard, they argue, for something that was never covered to be excluded.

Insurers say that the huge effort lavished on bug-squashing was not wasted. Companies did not simply replace their computers with the same model. They improved technology, upgraded systems and hence gained in productivity and competitiveness. Most of these changes would have been necessary at some stage, with or without the millennium bug. “Y2K remediation efforts were simply one part—and a small part at that—of doing business in today's high-tech world,” says Robert Hartwig at the Insurance Information Institute in New York.

Mr Hartwig categorically denies that companies were covered for Y2K costs by property insurance. The central idea of insurance is that it is based on the risk, not the certainty, of the occurrence of an event, and the millennium bug was not a “fortuitous” event but an entirely foreseeable one. Moreover, many lawsuits, including Xerox's, were filed when preparations for Y2K had been under way for several months. That runs against a provision in property insurance saying that insurers need to be notified of any claim as soon as practicable.

Like all branches of American industry, insurers are being confronted with an increasing number of lawsuits. In some ways they have to cope with a double whammy—lawsuits against themselves and lawsuits against their policyholders. The average jury award in suits against insurers in 1993 was $520,000, but by 1999 it had almost doubled to more than $1m, according to Jury Verdict Research, a division of LRP, a publisher which gathers information on jury settlements.

In October 1999, a judge in Illinois ordered the State Farm Mutual Auto Insurance Company in a class-action lawsuit to pay $456m in damages and an additional $730m in punitive damages to policyholders who had their cars repaired with generic parts rather than with parts from the original manufacturer of their car. The case sent shock-waves through the insurance industry and is under appeal. But it confirmed that insurance has become the latest sector to feel the full blast of America's zest for litigation.